CFPB Examination Procedures Auto Finance

CFPB Examination Procedures

Auto Finance

Automobile Finance Examination Procedures

Exam Date: Prepared By: Reviewer: Docket #:

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These Automobile Finance Examination Procedures Entity Name:

(Procedures) consist of modules covering the

Event No.:

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various elements of the automobile life cycle,

including the origination and servicing processes. Each module identifies specific matters for

review. Examiners will use the Procedures in examinations of automobile lenders, lessors, and

servicers. Before using the Procedures, examiners should complete a risk assessment and

examination scope memorandum in accordance with general CFPB procedures. Depending on

the scope, and in conjunction with the compliance management system review, including

consumer complaint review, each examination will cover one or more of the following modules.

Module 1 Company Business Model

Module 2 Compliance Management System

Module 3 Advertising and Marketing

Module 4 Application and Origination

Module 5 Payment Processing, Account Maintenance, and Optional Products

Module 6 Collections, Debt Restructuring, Repossessions, and Accounts in Bankruptcy

Module 7 Customer Complaints and Inquiries

Module 8 Credit Reporting, Information Sharing, and Privacy

Module 9 Examiner Conclusions and Wrap-up

Examination Objectives

1. To assess the quality of a supervised entity's compliance management system for preventing violations of Federal consumer financial law in its automobile loan or lease origination business or automobile servicing business.

2. To identify acts or practices that materially increase the risk of violations of Federal consumer financial law, and associated harm to consumers, in connection with an entity's automobile loan or lease origination business or automobile servicing business.

3. To gather facts that help determine whether a supervised entity engages in acts or practices that are likely to violate Federal consumer financial law in connection with its automobile loan or lease origination business or automobile servicing business.

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4. To determine, in accordance with CFPB internal consultation requirements, whether a violation of a Federal consumer financial law has occurred and whether further supervisory or enforcement actions are appropriate.

Background

This section of the Procedures provides background on the automobile finance business and the Federal consumer financial law requirements that apply.

The Dodd-Frank Act (12 U.S.C. 5514(a)(1)(B)) gave the Consumer Financial Protection Bureau (CFPB) supervisory authority over "larger participants" of certain markets for consumer financial products or services, as the CFPB defines by rule. In June 2015, the CFPB finalized its larger participant regulation in the market of automobile financing. The rule appears in 12 CFR 1090.108 and is effective 60 days after publication in the Federal Register. It provides that a nonbank covered person that engages in automobile financing is a larger participant of the automobile financing market if the person has at least 10,000 aggregate annual originations. Under the regulation, "automobile financing" generally includes grants of credit for the purchase of an automobile, refinancings of such obligations (and any subsequent refinancings thereof) that are secured by a vehicle, automobile leases, and purchases or acquisitions of any of the foregoing obligations. The rule provides that certain auto dealers do not qualify as larger participants1.

Consumers can acquire a vehicle using cash, financing the vehicle with an auto loan (indirect or direct), or leasing the vehicle for a defined period of time. Auto loans are closed-end (nonrevolving) amortizing consumer installment loans used for the purpose of acquiring a vehicle, usually a car, sport utility vehicle (SUV) or light-duty truck. Loan terms vary by the channel (indirect/direct), type of vehicle sought (new/used), and the credit profile of the consumer (credit score, debt-to-income ratio, bureau attributes). Leasing is acquiring a vehicle for a fixed period of time at an agreed amount of money.

Indirect Lending Channel

With indirect lending, dealers rather than consumers typically select the lender who will provide the financing. Upon completion of the vehicle selection process, the dealer usually collects basic information regarding the applicant and uses an automated system to forward that information to

1 Under section 1029 of the Dodd-Frank Act, the Bureau may not exercise its authority over certain auto dealers, as outlined in that section. The final larger-participant rule also excludes certain dealers that extend retail credit or retail leases directly to consumers without routinely assigning them to unaffiliated third party finance or leasing sources, even though such dealers are not subject to the statutory exclusion of section 1029. Specifically, the largerparticipant rule excludes those motor vehicle dealers that are identified in section 1029(b)(2) of the Dodd-Frank Act and are predominantly engaged in the sale and servicing of motor vehicles (as that term is defined in 12 U.S.C. 5519(f)(1)), the leasing and servicing of motor vehicles, or both. Thus, a typical Buy-Here-Pay-Here dealer would not be subject to the larger-participant rule, but a Buy-Here-Pay-Here finance company could a larger participant if it has at least 10,000 aggregate annual originations.

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prospective indirect automobile lenders. Most consumers who finance the purchase of an automobile use the indirect channel.

After evaluating the applicant, indirect auto lenders may provide the dealer with purchase eligibility criteria or stipulations, including but not limited to a risk-based "buy rate" that establishes a minimum interest rate at which the lender is willing to purchase a retail installment sales contract executed between the consumer and the dealer for the purchase of the vehicle. A franchised dealer often can choose from a selection of funding sources. However, a franchised dealer that is affiliated with a manufacturer can be incentivized to use a captive finance company (captive) through mechanisms such as promotional discounts or limited-time financing offers that can be used to attract consumers. A captive is usually a subsidiary of the parent organization (in the auto market, the parent is usually the manufacturer) whose purpose is to provide financing to consumers buying the parent company's products.

With the relevant eligibility criteria and stipulations, the dealer selects the indirect lender that will provide the financing and extends the credit through a retail installment sales contract that the indirect lender purchases or acquires. The dealer is typically compensated for arranging indirect financing. In the indirect lending model, the indirect automobile lender typically becomes responsible for servicing the retail installment sales contract and consumers will then make payments to the lender.

Most dealers use a standardized platform such as Dealer Track, Route One, or CUDL to collect credit application information in a single system. In turn, these platforms route the credit information to lenders based on the criteria provided, and the lenders make a preliminary decision to offer or not offer credit and provide approval terms to the dealers' finance and insurance (F&I) departments. This method allows dealers to match customers with a lender who will accept the loan.

Direct Lending Channel

Consumers seek out and negotiate their loan terms with a finance company or bank of their choosing, either before or after shopping for a vehicle. Consumers typically use their pre-existing relationships with a bank or finance company to obtain financing through the direct channel method.

Auto Leasing

Depository institutions have long engaged in auto leasing activities, and nonbank entities are a major player in the leasing sector. It is an important and growing part of the auto financing market for consumers. While the auto financing market is largely made up of purchase loans, in recent years, consumers have begun to migrate more towards leasing agreements.

Unlike the purchase of a vehicle, the consumer does not actually own the vehicle with a lien against a title. Instead, the consumer makes payments for the lease term. Auto leases are typically 12 months to 48 months in length, and include a "money factor" rather than an annual percentage rate (APR). An APR can be calculated by dividing the money factor by 2400.

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At the end of the lease term, a consumer has the option to purchase the vehicle for a prenegotiated balloon payment that is based on the residual value. The residual value is the dollar amount the consumer's leased vehicle is estimated to be worth at the end of the lease. The lender bears the risk that it has estimated the residual value correctly.

For consumers, leasing a vehicle requires an application process and an ongoing contractual obligation that are both financial in nature and similar to entering into a financial arrangement to purchase a vehicle. Like a consumer seeking to qualify for a loan to purchase a vehicle, a consumer seeking to lease a vehicle must provide basic financial information such as income and credit history. Though a consumer who leases an automobile need not finance the entire cost of the vehicle, the consumer still undertakes a major financial obligation in the form of a commitment to make a stream of payments over a significant period of time. The consumer must consider how much cash to use, if any, for a capitalized cost reduction (similar to a down payment), the preferred lease term, and the affordability of monthly payments and other costs, including maintenance, insurance, and state registration fees.

Buy Here Pay Here

Buy Here Pay Here (BHPH) finance companies are similar to captives in that they are associated with certain BHPH dealers. While BHPH dealers are mostly independently-owned entities that serve as the primary lender and receive payments directly from consumers, some larger BHPH dealers will sell or assign their contracts to specific BHPH finance companies once the contract has been consummated with the consumer. However, these BHPH finance companies do not focus on a particular auto manufacturer, unlike captives whose primary purpose is to extend credit to consumers who want to purchase or lease a specific manufacturer's vehicles.

Ancillary Products and Services

In addition to the actual vehicle, auto dealers and auto financers offer ancillary services and products at the time of vehicle purchase. These products can be distinguished by their association to either the vehicle purchase or the financing relationship.

? GAP Insurance: Also known as Guaranteed Auto Protection or Guaranteed Asset Protection, it is an insurance policy that covers the amount on a financing obligation that is the difference between the asset value and the amount covered by another insurance policy. In the event of total vehicle loss, the insurance policy covers the deficiency between the insurance settlement and the balance still owed. This insurance coverage is usually marketed for financing with small down payments, high interest rates, and/or extended terms (usually over 60 months).

? Extended Warranty: An extended warranty or vehicle service contract covers the costs of some types of repairs in addition to the manufacturer's warranty or after the manufacturer's warranty ends. These contracts typically exclude routine maintenance such as oil changes and tire replacement.

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? Vehicle Add-Ons: Also known as back-end products, these add-ons are other pieces of equipment or finishing items that can be purchased with the vehicle such as Lo-Jack systems, vehicle identification number etching (anti-theft precaution),and paint protection.

Applicable Laws/Regulations

Regardless of the channel or business model used by lenders to conduct business, the following Federal consumer financial laws may apply to an entity's auto financing activities:

? The Truth in Lending Act (TILA) and its implementing regulation, Regulation Z, require lenders to disclose loan terms and annual percentage rates. Regulation Z also requires lenders to provide advertising disclosures, credit payments properly, process credit balances in accordance with its requirements, and provide periodic disclosures.

? The Electronic Fund Transfer Act (EFTA) and its implementing regulation, Regulation E, protect consumers engaging in electronic fund transfers. Among other things, Regulation E prohibits lenders from requiring, as a condition of loan approval, a customer's authorization for loan repayment through a recurring electronic funds transfer (EFT) except in limited circumstances.

? The Fair Debt Collection Practices Act (FDCPA) governs collection activities conducted by third party collection agencies, as well as servicer collection activities if the servicer acquired the loan when it was already in default.

? The Fair Credit Reporting Act (FCRA) and its implementing regulation, Regulation V, require that furnishers of information to consumer reporting agencies ensure the accuracy of the data placed in the consumer reporting system. Additionally, the FCRA prohibits the use of consumer reports for impermissible purposes, and it requires users of consumer reports to provide certain disclosures to consumers. The FCRA also limits certain information sharing between affiliated companies.

? The Gramm-Leach-Bliley Act (GLBA) and its implementing regulation, Regulation P, require entities to provide privacy notices and limit information sharing in particular ways.

? The Equal Credit Opportunity Act (ECOA) and its implementing regulation, Regulation B, set forth requirements for accepting applications and providing notice of any adverse action, and they prohibit discrimination against any borrower with respect to any aspect of a credit transaction:

o On the basis of race, color, religion, national origin, sex or marital status, or age (provided the applicant has the capacity to contract);

o Because all or part of the applicant's income derives from any public assistance program; or

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o Because the applicant has in good faith exercised any right under the Consumer Credit Protection Act.2

If examiners identify concerns related to ECOA, they should consult with the Offices of Fair Lending and Supervision Policy, as those issues, except as specifically described herein, are beyond the scope of these procedures.

? The Consumer Leasing Act and its implementing regulation, Regulation M, require lessors to provide specific disclosures prior to the consummation or delivery of the consumer product, including disclosures in advertising.

? To carry out the objectives set forth in the Examination Objectives section, the examination process also will include assessing other risks to consumers that are not governed by specific statutory or regulatory provisions. These risks may include potentially unfair, deceptive, or abusive acts or practices (UDAAPs) with respect to lenders' or servicers' interactions with consumers.3 Collecting information about risks to consumers, whether or not there are specific legal guidelines addressing such risks, can help inform the CFPB's policymaking. Generally, the standards the CFPB will use in assessing UDAAPs are as follows.

o A representation, omission, act, or practice is deceptive when:

the representation, omission, act, or practice misleads or is likely to mislead the consumer;

the consumer's interpretation of the representation, omission, act, or practice is reasonable under the circumstances; and

the misleading representation, omission, act, or practice is material.

o An act or practice is unfair when:

it causes or is likely to cause substantial injury to consumers;

the injury is not reasonably avoidable by consumers; and

the injury is not outweighed by countervailing benefits to consumers or to competition.

o An abusive act or practice:

2 The Consumer Credit Protection Act, 15 U.S.C. 1601 et seq., is the collection of federal statutes that protects consumers when applying for or receiving credit. The Act includes statutes that have dispute rights for consumers, such as the Fair Credit Reporting Act. The ECOA prohibits discriminating against an applicant who has exercised a dispute right pursuant to one of the statutes outlined in the Act.

3 Section 1036 of the Dodd-Frank Act, PL 111-203 (July 21, 2010).

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materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service; or

takes unreasonable advantage of ?

? a lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service;

? the inability of the consumer to protect the consumer's interests in selecting or using a consumer financial product or service; or

? the reasonable reliance by the consumer on a covered person to act in the interests of the consumer.

Refer to the examination procedures regarding UDAAPs for more information about the legal standards and the CFPB's approach to examining for UDAAPs.

The particular facts in a case are crucial to a determination of UDAAPs. As set forth in the Examination Objectives section, examiners should follow the CFPB internal consultation requirements to determine whether the applicable legal standards have been met before a violation of any Federal consumer financial law is cited, including a UDAAP violation.

General Considerations

Completing the examination modules, as applicable, will allow examiners to develop a thorough understanding of a regulated entity's practices and operations. To complete the modules, examiners should obtain and review, as applicable, each entity's:

? organizational charts and process flowcharts;

? board minutes, annual reports, or the equivalent, to the extent available;

? relevant management reporting;

? policies and procedures;

? compensation structure and bonus programs for origination and servicing personnel;

? rate sheets;

? fee sheets;

? loan/lease applications and verification of information relied on in determining ability to repay;

? loan/lease account documentation, notes, disclosures, and all other contents of underwriting and closing files;

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? operating checklists, worksheets, and review documents;

? relevant computer program and system details;

? dealer agreements, due diligence and monitoring procedures, and origination (lending or leasing) procedures;

? underwriting guidelines;

? compensation policies;

? servicing related policies and procedures, such as those related to payment posting and payment allocation;

? service provider due diligence and monitoring procedures and service provider contracts;

? audit and compliance reports;

? management's responses to findings;

? training programs and materials;

? advertisements; and

? complaints.

Finally, examiners should obtain access to or a walkthrough of the entity's online origination interface and online applications; a walkthrough of the origination process to test the timeliness and completeness of disclosures; and a walkthrough and overview of the systems used for the servicing and collection of payments for automobile loans and leases, including any consumer interfaces.

Depending on the scope of the examination, examiners should perform transaction testing using approved sampling procedures, which may require use of a judgmental or statistical sample. Examiners also should conduct interviews with management and staff to determine whether they understand and consistently follow the policies, procedures, and regulatory requirements applicable to automobile financing and servicing; manage change appropriately; and implement effective controls. Examiners also should consider observing customer interactions and, if consumer complaints or document review indicate potential concerns, interviewing customers.

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